The Financial System is Built on Eggshells: Can Spain Avoid Default On Its Own?

The European financial system, like the others, is efficient but is not robust. It makes the most of what it has and runs on a razor edge between efficiency gains for individual agents and horrendous systemic losses. It depends crucially on the performance of its sovereign assets. System survival depends on one hand whether or not counterparties can absorb the necessary haircuts and on the other, whether fundamentals of debtor nations are strong enough to stand on their own.

Spain and Italy will have to stand on their own, because when Greece goes, Ireland will most likely go, which will in turn set off a critical mass such that the nation who dictates monetary policy (Germany) will be taking care of its own self.

Data on Servicing

Greece

Ireland

Italy

Portugal

Spain

Budget Deficit (% of 2010 GDP)

-10.2

-15.2

-6.3

-8.7

-10.1

Outstanding Debt (%of 2010 GDP)

135

84

119

86

65

Interest Payments to Revenue (% of 2010 GDP)

14 (2011=17)

8

10

8

6

Roll in the Next Twelve Months (% of total)

12

6

24

24

21

External Debt (% of total)

67

82

51

86

42

Domiciled Bank Exposure to Other Periphery (% 2010 GDP)

1

40

3

3

10

CDS Spreads (a few days ago)

1995

782

205

974

310

Source:Bloomberg, BIS

Macro data

Greece

Ireland

Italy

Portugal

Spain

Private Savings (% of GDP)

16

20

18

14

22

Unemployment Rate

13

13

9

10

20

Average Duration

8

7

8

8

7

Source: BIS, Eurostat

Nobody knows how flaky these numbers are, but the implications are plain:

There is insufficient growth to avoid serious austerity programs in any of these countries

Austerity programs will make growth even less likely

With the exception of Spain, most of the sovereign debt is held externally

Irish banks hold the equivalent of 40% (probably less now) of Irish GDP in other periphery debt instruments

With the exception of Greece and Ireland, a quarter of existing debt has to be refinanced in the next twelve months

Greece is just a situation of the irresponsibility found elsewhere only more so, and a lot of abuse is thrown between Greece and Germany. Ireland, however, acted like a hedge fund that made a business of collecting tail risks that they didn’t hedge. Thus, when Greece goes, Ireland—already distressed— goes. So why is it such a big deal if Ireland goes?

The following table shows you what banks domiciled in the US, France, Germany, and the UK are exposed to in terms of public and private debt, and also derivatives related to these exposures.

Exposure
in $ billions, Q1 2011

Greece

Ireland

Italy

Portugal

Spain

US

41.5

105

269

47

179

France

65

56

472

32

176

Germany

40

159

216

50

224

UK

19

194

100

29

138

Source: BIS

These exposures are just so big that they will require Germany, France, and the UK to forget about supporting sovereigns, as they will have to directly support banks domiciled in their countries. When these banks have to deal with these exposures, it causes even more stress because they are connected to each other in ways far beyond the issues of Greece, Ireland, Spain, Portugal, and Italy.

The payoff and losses here are nonlinear, so nobody knows what will happen. But it is clear that the US, the UK, France, and Germany are even more interconnected to each other and will suffer losses based on these interconnections.

Exposure
in $ billions, Q1 2011

Greece

Ireland

Italy

Portugal

Spain

US

41.5

105

269

47

179

France

65

56

472

32

176

Germany

40

159

216

50

224

UK

19

194

100

29

138

Source: BIS

*It is probably not possible to calculate the US-UK exposures, because the BIS requires report only bank exposures greater than 1% of assets, and in this case, probably these small exposure add up to a lot of unreported exposure.

When you think about these exposures, you need to apply a significant haircut here, but there could be short-long exposures that cancel each other out. But any losses will probably be more than the usual 40% recovery assumption simply because the losses will be correlated and pretty simultaneous. It is impossible to know the short-long composition of the derivative exposures. However, the following seems reasonable to infer:

If Ireland goes, the UK stands to lose a lot, as will Germany.

If Italy defaults, France will be in deep trouble. Their fate is tied to Italy with nearly a half trillion in exposure. Germany and the US and the UK have significant exposure to Italy as well.

After Italy, the next biggest in terms of exposure is Spain.

If this is really about minimizing banker losses, policymakers need to address how to keep Ireland from defaulting in the event of a Hellenic default. Once this plan is in place, let Greece go. I’m not sure that you can firewall this stuff off in this way. Probably what is needed is a firewalling of banks by applying an orderly settlement of exposures with steep haircuts.

This isn’t the end of the world. This means serious financial losses at issue, and events risk is seriously underpriced. One more time: fundamentals do matter. Good ones allow you to stand on your own.

I watched the Glen Beck show for about a half hour back in the spring when I was staying at the Bellagio. It was hard to watch. The guy is all over the place. Mind you, I did not say he was right or wrong, just all over the place. Such and such person is in cahoots with this person, who did something or another in the 70's, and this other person is a socialist who is married to this other Marxist ... It reminded me of Michael Crichton's, The State of Fear. I turned on cartoons.

dude fuck the jews, fuck the freemason, fuck the illuminati, and fuck everybody outside your cicle of 150 people,,,,, worry about peak oil that's the big equalizer. If u learn to farm and be REALLY self sufficient does it really matter what 20 percent makes it to the resourceLESS future?

Spain's "industry" which is real estate and home building for the biggest part is "build" on the "under the counter money" of Europe.

That means: Everybody who has black money which they want to put to "good" use puts it in a bag and drives it to Spain to buy some property.

This is also the reason there was a housing boom from 2000 to 2007.

When that money dried up and every country was checking out second houses to look for extra tax money and also initiated free repatriate programs for that kind of money, the Spanish housing market popped.

That was also the moment people started to notice that the surplus on vacation homes in Spain was so vast and totally not profitable that the word "investment" was the starting word for any joke in Europe.

The housing marketboom is death. The surplus is endless. And that created a 20% unemployment rate in Spain that can't be fixed.

Also Europe is broke. People don't have these amounts of money anymore to build extra houses like that and who would they? There's enough stock to buy some on the cheap. Also the tax bounty hunters won't allow them anymore.

A second note is that because Spain is broke, they'll need extra tax revenue. And why not tax foreigners, rich ones that is, a bit more instead of their broke unemployed citizens?

Which will brake the housing market and industry even more.

Spain is living on borrowed time. The good times are over. They are eating their reserves, the people that is.

And then there are the ecological problems... Spain has been turning into a desert for almost 2 decades now and that shit is bad.

While Spain is of interest to me, the bigger implication of the data is that Greece impacts Ireland most unfavorably. An Iris debt default will be very, very bad for the UK and Germany, which will in turn be very bad for the planet.

This whole Italian flare-up is completely ominous for France.

At some point the only way to stop the chain reaction is to end the policy of bailing out banks whilst leaving bondholders intact. I believe something will have to give here, the sooner the better, and country fundamentals will stand on their own.

There is something of a floor on Spanish real estate. Prices get really cheap and droves of English and Germans will scoop them up.

However, Spain is not a true sovereign because it doesn't print its own money, and issue debt in that money.

This puts them at a huge disadvantage to countries like Poland and Vietnam.

Good story but missing the impact of 22% + unemployment and an incredible rate of residential mortgage default with no HAMP bailout AND no debt forgiveness built into the tax or civil court system. That's where this could go from a domestic real estate crash into violence pretty darned quick.

"Argentina's government says the country's inflation rate is 9.7%. Most independent economists put the figure at 20%. So the government has filed criminal charges against one consulting firm, MyS for "publishing false information about inflation data," part of a coordinated campaign against independent economists."

...it's not the end of the world you say? Come on, the new versions of the Great Depression Bucketheads broke the Glass Stegall seal etc... and created the black hole on purpose. To think or suggest otherwise (as if it ain't the end built in) defines the prophetic strong delusion upon our dusty asses. ''They'' know exactly what they are doing, it's called the mark of the beast bitchez, and the exposure is not a choice, the shit is in the wind. You cannot buy sell or trade outside of the global mark to myth prison and you sure as hell are not going to escape the demand destruction of the black hole these bastards call the ''moral hazard'' when it's really their offers of temptation, as they are not their brothers keeper Bitchez. http://www.youtube.com/watch?v=DTsi3g5s-zs&feature=related

no one was predicting Italy as a problem and in fact as one person who saw it as such the vehemence of the counter-attack only convinced me that emotion still ruled...or more accurately over-ruled good, hard honest debate such that problem solving could begin. The irony is of course that those who shout down the reality of the euro-land implosion are the last to come to her defense. this WAS an emminently preventable crisis--but the ECB just keeps raising rates--for what purpose no one i think wishes to divine. so now we will see...

Numbers, numbers. They only have meaning as long as the basic rules hold, but these are melting away, fast. In the end what counts is how do you keep the labor force producing things.

Unfortunately our labor force (including oil, coal and gas) gets smaller by the day due to sinking EROEI. Our current financial system is simply not made to cope with this fact and nobody has any idea of a system that actually would work reasonably well under this conditions.

This is a fantastic post! Thanks Tyler... What really catches my {EYE} is those Line 1) GDP numbers, and the fact that Italy is ready to cave in with the lowest numbers. Priceless.@ -6.3% Thanks again +1

What is most interesting to me is the roll figures combined with the % of revenue paid to interest.

Spain has to refi ~20% in the next twelve months. Let's say they refi with a 5Y and the coupon rises to 10%. They are still only paying about 12 cents of revenue to debt service for this fraction of their debt. This takes them to about 8 cents overall. Totally doable.

Italy has to refi about 25% of their debt in the next twelve months. They are already paying 20 cents of revenue on debt service. If they have to take a doubling of coupon on 25% of this debt, you are reaching a painful spot.